Global Networks, Monetary Policy and Trade

This work develops a new framework to analyze the macroeconomic impact of trade distortions under global imbalances. Our New Keynesian Open Economy (NKOE) model incorporates trade and production networks with full input-output linkages, sectoral heterogeneity in price rigidities, and country heterogeneity in monetary policy. A key theoretical insight is that the dynamics of the inflation-output trade-off and the unemployment impact of the tariff shock depend on the complementarity within the global production networks and international risk sharing; crucially, we introduce the NKOE Leontief inverse, which enables a more robust analysis of macroeconomic variables through the economy-wide propagation of tariff distortions. The overall macroeconomic impact of tariffs depends on the endogenous monetary policy responses of both tariff-imposing and tariff-exposed countries, even in the absence of retaliation. The quantitative exercises based on data from 2025 tariffs imposed by the U.S., on Mexico, Canada, China, the Euro Area, and the rest of the world (ROW) predict stagflation for all, with the largest increase in inflation in the U.S. and the biggest drop in output in Mexico. Exchange rate movements depend on the heterogeneous monetary policy responses and the nature of the shock—the dollar appreciates less or can even depreciate under tariff threats. Threats, even without implementation, are self-defeating as they lead to deflation and lower output.